Edwards Lifesciences Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Amounts are in U.S. dollars; financial figures are in millions except per-share data. The company develops and sells cardiovascular products in Transcatheter Heart Valves, Surgical Heart Valve Therapy, and Critical Care.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $575.1 | $517.2 | $1,097.5 | $1,013.9 |
| Gross profit | $423.9 | $393.6 | $800.4 | $769.3 |
| Gross margin | 73.7% | 76.1% | 72.9% | 75.9% |
| Net income | $547.0 | $93.3 | $607.3 | $237.2 |
| Diluted EPS | $5.09 | $0.81 | $5.63 | $2.05 |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $916.9 | $229.2 |
- Q2 sales rose 11.2%; six-month sales rose 8.2%. Transcatheter Heart Valve sales grew 20.6% in Q2 and 16.2% for the first half, led by SAPIEN 3 in Europe and SAPIEN XT in Japan. Six-month growth was strongest internationally; U.S. sales were down 0.9%.
- Gross margin declined 2.4 percentage points in Q2 and 3.0 points for the first half. Management cited currency and hedging effects, estimated valve-product returns, and related inventory write-offs during product launches.
- SG&A was $215.5 in Q2 and $412.7 for the first half; R&D was $89.1 and $174.9, respectively. First-half R&D equaled 15.9% of sales. Spending increases reflected commercial support, clinical studies, product development, and incentive compensation.
- Reported net income and EPS were heavily affected by the Medtronic settlement described below and are not representative of recurring operating performance. Q2 included a $50.0 charitable foundation contribution; the first half also included a $7.5 intellectual-property agreement settlement charge.
- First-half operating cash flow included the Medtronic payment and was also affected by a $282.7 increase in accounts payable and accrued liabilities. Investing cash outflow was $590.2, mainly net investment purchases of $561.2 and capital expenditures of $30.3. Financing cash outflow was $247.6, including $300.6 of treasury-stock purchases.
Liquidity, debt, and balance sheet
- At June 30, cash and cash equivalents were $498.6; short-term investments were $985.5 and long-term investments $99.0. Cash and short-term investments totaled $1,484.1.
- Long-term debt carrying value was $598.0, comprising 2.875% unsecured senior notes due October 2018. No borrowings were outstanding under the prior $750.0 credit facility at quarter-end. In July, the company replaced it with a five-year $750.0 facility, with lender approval required for any increase of up to an additional $250.0.
- Current assets were $2,278.1 and current liabilities shown as accounts payable and accrued liabilities were $540.5. The company reported stockholders’ equity of $1,914.9.
- Management said available cash, investments, credit facilities, and operating cash flow were sufficient for working capital, capital expenditures, and other commitments for the next 12 months. $767.6 of cash and short-term investments was held outside the U.S.; repatriation may face restrictions and taxes.
Material changes and unusual items
- Medtronic settlement: In May 2014, the parties settled outstanding patent litigation, dismissed pending cases and appeals, and agreed not to litigate transcatheter-valve patent disputes for eight years. Edwards received a $750.0 upfront payment, recognized in Q2 as intellectual-property litigation income. The agreement also provides quarterly royalties through April 2022; U.S. sales royalties have a minimum annual payment of $40.0 and maximum of $60.0. Additional consideration allocated to license and covenant-not-to-sue elements, and past damages in excess of cash received, is to be recognized over time as applicable. The filing reports $487.9 after-tax benefit from the upfront payment.
- The $50.0 contribution to the Edwards Lifesciences Foundation was irrevocable and expensed in Q2. The related-party foundation provides philanthropic support to health- and community-focused organizations.
- Effective January 1, 2014, the company changed its accounting for certain patent-defense and enforcement legal costs from capitalization to expense as incurred, retrospectively adjusting prior periods. The 2013 comparative figures shown reflect this change. The company also revised the six-month 2013 cash flow statement for a nonmaterial capital-expenditure accrual classification error, increasing operating cash flow and investing cash outflow by $14.9.
- In July, the board approved a new $750.0 share-repurchase program. At June 30, $202.5 remained under the existing program; the company had repurchased 4.4 million shares for $300.0 during 2014.
Outlook, commentary, and risks
- No specific full-year revenue, earnings, or EPS guidance is provided in the supplied filing text. Management expected increased competition in Transcatheter Heart Valves as competitors introduced products in the U.S. and Europe.
- Management attributed growth to the SAPIEN 3 European launch and SAPIEN XT launch in Japan. U.S. FDA approval for SAPIEN XT in high-risk and inoperable patients was received in June; SAPIEN 3 received a European CE Mark in January. The ClearSight noninvasive monitoring system received FDA clearance in June.
- Product-transition returns and inventory effects, foreign-exchange movements, competition, clinical and regulatory outcomes, and the ability to sustain growth are key operating considerations. The filing also identifies investment-value risk, including potential impairment of private-company investments.
- Tax exposures remain uncertain: liabilities for uncertain tax positions were $172.0 at June 30, with transfer-pricing matters and U.S.–Swiss advance-pricing-agreement negotiations still unresolved. The filing cautions that final tax outcomes may differ from recorded amounts.
- Other legal matters may result in charges above reserves, although management did not believe currently pending lawsuits would materially affect financial position, results, or liquidity. Management reported disclosure controls as effective and no material change in internal control over financial reporting during the quarter.
Investor verification points
- Separate recurring sales and operating performance from the $750.0 Medtronic payment, its tax effects, and the $50.0 charitable contribution when assessing earnings and cash generation.
- Review the settlement’s royalty terms, duration, accounting allocation, and future recognition, including the stated U.S. annual royalty floor and cap.
- Track gross margin, product-return reserves, inventory write-offs, and launch-related sales trends as SAPIEN 3 and SAPIEN XT rollouts progress.
- Assess the composition and availability of liquidity, including overseas cash, repatriation costs, debt maturity, and covenants under the replacement credit agreement.
- Monitor transfer-pricing and other uncertain tax positions, outstanding legal contingencies, and potential investment impairments.